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The Dangerous Myth About The Bill Clinton Tax Increase

Charles KadlecContributorOpinions expressed by Forbes Contributors are their own.

I cover economic/political issues with liberty as my polar star.

"The real lesson of the Clinton Presidency is the way back to prosperity lies not through increased taxes on “the rich,” but through tax and regulatory reform and a return to a rules based monetary policy that produces a strong and stable dollar."(Image credit: AFP/Getty Images via @daylife)

One of the most dangerous myths that has infected the current debate over the direction of tax policy is the oft repeated claim that the tax increases under President Bill Clinton led to the boom of the 1990s. In their Wall Street JournalOp-Ed last Friday, for example, Clinton campaign manager James Carville and Democratic pollster and Clinton advisor Stanley Greenberg write the increase in the top tax rate to 39.6% “produced the one period of shared prosperity in this past era (since 1980).”

While this myth is now a central part of liberal Democratic folklore, it is contradicted by the political disaster and poor economic results that followed the tax increase. The real lesson of the Clinton Presidency is the way back to prosperity lies not through increased taxes on “the rich,” but through tax and regulatory reform and a return to a rules based monetary policy that produces a strong and stable dollar.

The 1993 Clinton tax increase raised the top two income tax rates to 36% and 39.6%, with the top rate hitting joint returns with incomes above $250,000 ($400,000 in 2012 dollars). In addition, it removed the cap on the 2.9% Medicare payroll tax, raised the corporate tax rate to 35% from 34%, increased the taxable portion of Social Security benefits, and imposed a 4.3 cent per gallon increase in transportation fuel taxes.

If these tax increases were good for the middle class, then they should have been popular. Yet, in the 1994 elections, the Democratic Party suffered historic losses. Even though Senate Majority Leader George Mitchell had declared the unpopular HillaryCare dead in September of that year, the Republican Party gained 54 seats in the House and 8 seats in the Senate to win control of both the House and the Senate for the first time since 1952.

Second, Messrs. Carville and Greenberg are contradicted by their former boss. Speaking at a fund raiser in 1995, President Clinton said: ”Probably there are people in this room still mad at me at that budget because you think I raised your taxes too much. It might surprise you to know that I think I raised them too much, too.”

During the first four years of his Presidency, real GDP growth average 3.2%, respectable relative to today’s economy, but disappointing coming as it did following just one year of recovery from the 1991 recession, the end of the Cold War and the reduction in consumer price inflation below 3% for the first time (with the single exception of 1986) since 1965.

For example, it was a half a percentage point slower than under Reagan during the four years following the first year of the recovery from the 1982 recession.

Employment growth was a respectable 2 million a year. But real hourly wages continued to stagnate, rising only 2 cents to 7.43 an hour in 1996 from $7.41 in 1992. No real gains for the middle class there.

Federal government receipts increased an average of $90 billion a year while the annual increase in federal spending was constrained to $45 billion. That led to a $183 billion, four-year reduction in the budget deficit to $107 billion in 1996.

However, with his masterful 1995 flip-flop on taxes, President Clinton took the first step toward a successful campaign for re-election and a shift in policy that produced the economic boom that occurred during his second term.

Welfare reform, which he signed in the summer of 1996, led to a massive reduction in the effective tax rates on the poor by ameliorating the rapid phase out of benefits associated with going to work.

The phased reduction in tariff and non-tariff barriers between the U.S., Mexico and Canada under the North American Free Trade Agreement continued, leading to increased trade.

In 1997, Clinton signed a reduction in the (audible liberal gasp) capital gains tax rate to 20% from 28%.

The 1997 tax cuts also included a phased in increase in the death tax exemption to $1 million from $600,000, and established Roth IRAs and increased the limits for deductible IRAs.

Annual growth in federal spending was kept to below 3%, or $57 billion.

The Clinton Administration also maintained its policy of a strong and stable dollar. Over his entire second term, consumer price inflation averaged only 2.4% a year.

The boom was on. Between the end of 1996 and the end of 2000:

Economic growth accelerated a full percentage point to 4.2% a year.

Employment growth nudged higher, to 2.1 million jobs per year as the unemployment rate fell to 4.0% from 5.4%.

As the tax rate on capital gains came down, real wages made their biggest advance since the implementation of the Reagan tax rate reductions in the mid 1980s. Real average hourly earnings were (in 1982 dollars) $7.43 in 1996, $7.55 in 1997, $7.75 in 1998, $7.86 in 1999, and $7.89 in 2000.

Millions of Americans shared in the prosperity as the value of their 401(k)s climbed along with the stock market, which saw the price of the S&P 500 index rise 78%.

Revenue growth accelerated an astounding 59%, increasing on average $143 billion a year. Combined with continued restraint on government spending, that produced a $198 billion budget surplus in 2000.

Shared prosperity indeed! But one created not by raising tax rates on high income but not yet rich middle class families, and certainly not by raising the capital gains tax rate or by imposing the equivalent of the Buffett rule, a new alternative minimum tax of 30% on incomes over $1 million, nor by massively increasing federal spending.

Rather, it was a prosperity produced by freeing America’s poor from a punitive welfare system, lowering tariffs, reducing tax rates on the creators of wealth, limiting the growth of federal government expenditures, and providing a strong and stable dollar to businesses and families in America and throughout the world.

A shared prosperity can be achieved again. But to do so, the American people will have to overcome the envy feeding myth perpetrated by President Barack Obama and the spin-masters and leadership of the Democratic Party that raising tax rates on high incomes will somehow lead to more job creation, more opportunity and increased prosperity and security for the middle-class.

I am the Founder of Community of Liberty, a chapter based organization committed to pursuing the art of living in liberty, a member of the Publication Committee of the…Read More

I am the Founder of Community of Liberty, a chapter based organization committed to pursuing the art of living in liberty, a member of the Publication Committee of the Claremont Review of Books, an Advisor to TheGold StandardNow.org, and a juror for the Bastiat Prize for Journalism. I have just published with my co-author Ralph Benko the booklet, "The 21st Century Gold Standard: For Prosperity, Security and Liberty," now available as a free download at AGoldenAge.com. I bring to my columns an extensive background in the investment management business, including my experience as an equity portfolio manager, strategist, president of my former firm’s retail sales and marketing subsidiary and member of the parent firm’s management committee. As such, I have been a student and observer of the political/economy and its affects on markets, businesses, and my own business for more than 30 years.Read Less